Reason #1: lawsuits
The United States is the most litigious country on earth, and the threat of a lawsuit can affect anyone who owns almost any amount of assets. The more assets you have, the more likely you are to face a lawsuit at some point in your life. In the legal field, this is sometimes referred to as the deep pockets theory — litigants have an obvious preference to legally pursue people who have the means to pay a claim.
A lawsuit can come from any direction — from a family member, a neighbor, a former friend, a previous employer, an employee of your business, or an aggrieved party in a business transaction. The basic purpose of a lawsuit is to gain control of your assets as a form of remuneration to compensate for a real or perceived loss.
For the most part, when you’re talking about lawsuits, you’re talking about protecting yourself from an assault on your assets.
How a trust can protect your assets from lawsuits. By setting up an irrevocable trust you can protect your assets from legal challenges and creditors. This is a living trust, or inter vivos trust, since it's created while you are alive.
An irrevocable trust requires three provisions:
- It cannot be amended or canceled by you (which is why it’s called “irrevocable”)
- The trust must have a separate trustee, and cannot be controlled by you, and
- The trust must file its own income tax return
By setting up an irrevocable trust, you're creating a separate legal entity with ownership and control over your assets. Courts and creditors can still go after any assets you own personally, but not the assets in the trust.
The other type of trust is a revocable trust, which is a trust you control, that can be amended or canceled, and allows income to flow to you personally for income tax purposes.
In most states, revocable trusts won’t provide protection from lawsuits and creditors. Since you have control over it, the law generally considers it part of your personal assets, and therefore subject to seizure or attachment for legal claims and by creditors.
Reason #2: Death
Most people assume their assets will be properly dispersed upon their death as a result of having a will. While that’s generally true, there are often complications that occur at death, particularly upon the death of a person with substantial assets. A trust can offer a greater level of protection if this is the case.
What are some of the problems that could arise as a result of your death?
- The assets of your estate could be squandered, since there is no legal entity established for the purpose of protecting and dispersing your assets according to your wishes.
- Your heirs could squabble over who gets how much, and which assets they get.
- A relation who you specifically excluded from your will could assert a claim on your estate, and tie the estate up in costly litigation.
- Certain liabilities (like a home mortgage) that you directed to have paid off, may never be paid.
- Assets you directed into a specific charity may never get there.
- A creditor could assert a claim against your assets upon your death — and your will won’t protect your estate from this claim.
An estate — especially a complicated one — won’t always be best protected and dispersed as a result of having a will. And that’s where trusts come in.
How a trust can protect your assets in the event of your death. If disbursement of your estate is the primary reason for the trust, you can use either a revocable or an irrevocable trust.
You can also use a testamentary trust, which is a trust that will be created upon your death, and funded by the assets in your estate or by life insurance proceeds. The advantage to using a testamentary trust is you won’t have to maintain the trust during your lifetime, with all of the effort and cost it will involve.
Like a will — but often with more certainty — a trust can ensure your estate is divided up according to your wishes as expressed in the trust documents. Since the trust has direct control over your assets upon your death, there's greater certainty they will be distributed according to your specific wishes.
Most importantly, a trust will enable your estate to pass without having to go through probate. Probate can take months to complete, and sometimes more than a year. It's more complicated in some states than in others, and the fees associated with it can take a big chunk out of your estate.
Just as important, probate is a process you don’t want your family to go through, especially on top of your death. The delay can be taxing on the emotions, and cause a financial hardship. A trust is worth having for avoiding probate alone.